NIKE Earnings Preview: Growth in North America and Europe to Drive Nike

Sports giant Nike is scheduled to report its Q3 2014 results on March 20. The company’s results in the previous quarter were encouraging on account of an 8.4% year-over-year growth in the top line and 1.4% expansion in gross margins. We expect the company to match its growth rate in the previous quarter on account of above industry wide growth over the holiday period, strong sales recorded by footwear retailer
Foot Locker(two-thirds of the shoes sold by FL are
Nike’s) and good performance across all geographies excluding Japan.

In the second quarter of Fiscal 2014, Nike’s revenues from continuing operations were up by 8.4% to $6.4 billion. Gross margin increased 140 basis points to 43.9 %, driven by a sales mix of higher margin products and businesses, higher average prices, lower input costs and continued strength in the higher margin Direct-to-Consumer business. Nike’s Footwear division was especially strong over the quarter recording sales growth of 10% in North America, 27% in Western Europe, 16% in Central and Eastern Europe and 10% in Greater China. NIKE Brand apparel’s performance differed across geographies – while the company’s performance in Central and Eastern Europe was strong with an 18% growth, the company only posted mid single digit growth rates in North America, Western Europe and Greater China. The Nike brand DTC revenue increased 19% driven by 10% comp store growth, new stores, and the strong increase in online sales.

Category Offense Is Fueling Growth For Nike

Nike is focusing on individual product categories such as running, football, basketball and men’s training to drive innovation and incremental sales in these product categories.

Running and basketball are two categories for Nike that are witnessing high growth and have strong market potential. The company is tapping growth in these categories by providing innovative technologies such as Nike Free, Lunar, Flyknit and Dri-Fit, as well as leveraging partnerships with leading athletes, such as Kobe Bryant and LeBron James. We expect these two categories to continue to grow at a strong rate in the future.

Regional Performances

a) North America represents the biggest market for Nike, accounting for ~40% of its revenues. The company is the market leader in the North American athletic footwear market, with nearly 60% market share. Moreover, sales in the footwear category are driven by the basketball category, which has higher margins than other footwear categories. Nike’s strong footwear performance is based on using endorsements by iconic figures such as Michael Jordan and Kobe Bryant to sell its products. New endorsement deals, such as those with Lebron James and Kevin Durant, should help Nike retain the same strength over the coming quarters. Additionally, strong performance over the holiday period despite severe weather conditions demonstrated strength in the company’s Direct to Consumer business.

b) Emerging markets (excluding China) revenue fell by 5% on a currency neutral basis, due to supply chain issues in Mexico. Weaker currencies were also a significant financial drag in the emerging markets geography. Emerging markets provide long term growth opportunity for Nike, and the company will leverage international sporting events such as the FIFA World Cup and Olympics in Brazil to drive its future sales.

With growing economic prosperity in the region, Central & Eastern Europe represents another fast growing market for Nike. Not only did the company’s sales jump 17% in the second quarter, the futures orders also stood at a promising 13% (in constant currency terms) at the end of Q2. Therefore, we believe this region will continue to be a strong growth driver for Nike in the near future.

c) China is expected to hold the key to Nike’s future growth, owing to its large population and a fast growing economy. However, Nike’s Chinese sales have been hit in the recent past due to ineffective brand positioning, which led to a long drawn process of clearing out excess inventory by offering discounts. The company is actively addressing this situation by focusing its assortment with a greater level of precision on the sports and the products that are most preferred by Chinese consumers.

Nike has also setup new distribution centers and increased its marketing capacity in the region. The sales figure in the face of this restructuring process will be a key indicator of Nike’s health in China. In an encouraging sign, Nike’s revenues from the Greater China rose 5% in Q2. While the recovery is expected to take some more time, we think the futures orders growth of 4% indicates demand is starting to pick up in Greater China (i.e. Mainland China, Hong Kong, Taiwan etc).

Outlook for Q4 2014

We expect to see gross margin expansion driven by higher average prices, lower raw material costs and growth in direct-to-consumer sales, partially offset by higher discounts to clear inventories in Mexico and China, start-up costs for expansion of distribution centers and stiffening currency headwinds. Expenses on demand creation and ongoing investments in strategic initiatives, such as marketing for FIFA World Cup 2014, are also expected to eat into Nike’s profit margins. There will be more volatility in the year-over-year comparisons of margins due to the timing of key sporting events this year and last.